Trump's reflation rally will short-circuit. Rising borrowing costs will blow fuses across the world before fiscal stimulus arrives, if it arrives.
By the end of 2017 it will be clear that little has changed. Powerful deflationary forces retain an invisible grip over the global economy. Bond yields will ratchet up further and then come clattering down - ultimately driving 10-year US yields below zero before the decade is over.
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Trump playing a Nixon game
It looks like Trump is going to Russia for much the same reason Nixon went to China. Michael Pascoe comments.
There are few "shovel ready" projects for Donald Trump's infrastructure blitz. The headline figures are imaginary. Congress will whittle down his plan.
The House will pass tax cuts for the rich but these are regressive, with a low fiscal multiplier. An anti-deficit Ayatollah at the budget office implies a spending purge. This will hit the poor, with a high multiplier.
This Gatsby mix is economically self-defeating. To the extent that there is any extra juice, it will be countered by the Federal Reserve at this late stage of the cycle. Tight money will push the dollar higher.
Once markets accept that Trump is not bluffing - that he means to smash globalism - euphoria will give way to alarm, but for now Wall Street remains intoxicated on wishful thinking. The longer the delusion lasts, the stronger the dollar, and the greater the trouble in Asia and Latin America.
Such is the currency paradox. As the Fed's broad dollar index pushes towards an all-time high of 130, the mechanical effects will expose the Achilles Heel of an international system that has never been more dollarised.
King dollar will tighten the noose on emerging market debtors with $US3.5 trillion ($4.9 trillion) of dollar liabilities. It will force banks in Europe - through complex hedging contracts - to curtail offshore lending to the Pacific Rim, Turkey, Russia, Brazil, and South Africa. It will perpetuate the credit crunch in the developing world.
China moves to a different rhythm but it cannot insulate itself from higher US borrowing costs. The imported squeeze will come just as the latest 18-month boomlet rolls over.
It is whispered - and always denied - that the US agreed last February to delay rate rises, buying time for China to calm the yuan panic. Next time there will be no such accord. The Trumpians want China to blow up, willing to tolerate the blow-back.
Draconian controls will not stem capital flight. The nuclear risk through 2017 is that Beijing's "weak yuan" mandarins will prevail. If they let the exchange rate go, the Asian currency storm will set off a deflationary tsunami.
My New Year's piece last year spoke of sunlit uplands: "The economic sweet spot of 2016 before the reflation storm." I hoped the treacherous moment could be deferred until 2017. Unfortunately we are now there.
The tailwinds of global recovery are fading. We have already enjoyed the $US2 trillion consumer windfall of cheaper oil. Europe has had its austerity relief. The European Central Bank is played out. On a flow basis it will soon be tapering, and therefore tightening.
Yields on Italian debt will climb above the growth rate of nominal GDP as markets anticipate the loss of the ECB shield. This means attrition on €400 billion ($582 billion) of sovereign paper held by banks, eroding capital buffers. Rome's €20 billion fund for bank rescues will run dry within months.
None of the elections in Holland, France, or Italy will bring an anti-euro government to power, but they will come close enough to rattle nerves and drive the euro below dollar parity.
The parliamentary balance will shift, weakening the ideological lockhold of the Maastricht elites and free movement purists. The centre-Right will harden everywhere to stop leakage to the populist fronts.
Brexit Britain will no longer stick out in the same way. It may even start to look like a liberal haven set against Europe's unanswered rage, and this will change the narrative.
The UK economy will not perform any better than the eurozone, but it will not do any worse either, and those who talk of "punishing" Britain in EU capitals will discover the asymmetry of political risk.
The British can perhaps fall back on the Dunkirk spirit. Brussels can fall back on nothing.
The Daily Telegraph, London
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